Testimony Concerning
The Competitive Market Supervision Act

Before the Senate Committee on Banking, Housing, and Urban Affairs

February 28, 2000

Chairman Gramm, Ranking Member Sarbanes, and Members of the Committee:

I appreciate the opportunity to testify before you today on behalf of the Securities and Exchange Commission ("SEC" or "Commission") regarding the proposed "Competitive Market Supervision Act."

Today, the Congressional Budget Office ("CBO") estimates that fees required to be collected by the SEC from all sources will total nearly $2 billion in fiscal 2001.1 This represents almost five times the SEC's fiscal 2001 budget request of $423 million. As we have stated in the past, the Commission shares the Committee's concerns regarding these excess fee collections. Even more importantly, the Commission greatly appreciates the Committee's recognition of the staffing crisis we currently face. Keeping staff and increasing our funding certainty through rationalizing the Commission's fee collections are fundamental to fulfilling the SEC's mission of protecting investors and maintaining the markets' integrity.

The proposed "Competitive Market Supervision Act" largely meets many of the concerns regarding fee collections that the Commission has set forth in prior testimony. In particular, it reduces the total fee collections that the SEC will be required to collect while improving the likelihood that the SEC will receive adequate funding. It also spreads the costs of regulation among those that benefit from the activities of the Commission.2 We commend you for this effort to achieve significant fee reductions in a comprehensive manner. Approximately 70 percent of SEC fee collections go to the general fund of the U.S. Treasury and are therefore used to support other federal programs. I understand there are larger tax and equity issues involved in this area that may be of concern to the Administration. We particularly applaud you for addressing our staffing crisis by giving us the ability to match the pay and benefits of the federal banking agencies. We look forward to working toward this bill's passage through a reasoned and inclusive dialogue with you and other interested parties.

Given the complexity of the issues involved in fee reduction, we will first briefly review the current fee collections situation and its relationship to the SEC's funding structure before addressing the current proposal in more detail. We will then address our need for pay parity.

Current Fee Collections and SEC Funding Structure

In our testimony before the Securities Subcommittee last year, we gave an overview of the history of SEC fees, the fee agreement contained in the National Securities Markets Improvement Act of 1996 ("NSMIA"), the impact of the Budget Enforcement Act on the fee debate, and the SEC's own efforts to reduce fees.3 Today, we would like to focus on the current fee collections situation and its relationship to the SEC's funding structure.

Federal securities laws direct the Commission to collect three different types of fees.

Securities registration fees (so-called "Section 6(b) fees" because they are required to be collected under Section 6(b) of the Securities Act of 1933) are paid when securities are registered with the Commission for sale (for example, by corporations and investment companies).

Securities transaction fees (so-called "Section 31 fees" because they are required to be collected under Section 31 of the Securities Exchange Act of 1934 ("Exchange Act")) are paid when securities are sold on exchanges and in the over-the-counter ("OTC") market.

Fees on mergers and tender offers (and other significant transactions) are paid when transaction documents are filed with the Commission. These fees are required by various provisions under the Exchange Act.

Almost 70 percent of the fees collected from these three sources goes to the U.S. Treasury as general revenue, including a large portion of Section 6(b) fees, Section 31 fees on transactions involving exchange-listed securities, and all fees collected on mergers and tender offers (and other significant transactions). The remaining portion of fee collections goes to "offsetting collections," including a small portion of Section 6(b) fees and Section 31 fees on transactions subject to "last sale reporting" on the OTC market.

The distinction between the general revenue portion and the offsetting collections portion of fee collections is central to understanding the SEC's funding structure. This is because our appropriators use offsetting collections to fund SEC operations, making offsetting collections crucial to full and stable long-term funding for the SEC. Unlike the offsetting collections portion of fee collections, the SEC has not received an appropriation from general revenue for the last several years. This means that the general revenue portion of fee collections, which CBO projects to be more than $1.3 billion in fiscal 2001,4 is used to fund government programs unrelated to the SEC's mission.

Some may argue that the SEC was meant to be funded through general revenue under the compromise reached in NSMIA. In fact, the gradual increases in general revenue funding for the SEC contemplated  though not legally required  by the NSMIA compromise have not occurred.5 This is because of the tremendous market growth we have witnessed in the last few years. This growth has far exceeded the 1996 estimates on which NSMIA was based, resulting in fee collections well in excess of original estimates. Unfortunately, the potential for either excess collections or shortfalls is inherent in activity-based fees.

The following chart shows current CBO estimates of SEC fee collections broken down between those that go directly to general revenue and those that go to offsetting collections:

As the chart illustrates, total fee collections are currently projected to increase through fiscal 2006, and then fall sharply in fiscal 2007. This is because under current law both the general revenue portion of Section 6(b) fees and all Section 31 fees will be reduced dramatically in fiscal 2007  the Section 6(b) fee rate will be reduced from the current 1/50th of 1 percent of the aggregate offering price of the securities to 1/150th of 1 percent and the Section 31 rates will be reduced from their current 1/300th of 1 percent of sales to 1/800th of 1 percent. In addition, the offsetting collections portion of Section 6(b) fees are gradually being eliminated over a multi-year period ending in fiscal 2006.

Competitive Market Supervision Act

The proposed "Competitive Market Supervision Act" achieves meaningful reductions in fee rates in a comprehensive manner. It significantly reduces the burden of excess fees not only on investors and the nation's securities markets, but also on the capital-raising process. By targeting all three types of SEC fees for reduction, the proposal spreads the benefits of fee reduction among all those who pay for the costs of regulation. Specifically, the proposal further reduces the Section 6(b) fee rate from the scheduled reductions under current law to $67 per million in fiscal years 2001 through 2006, and to $33 per million in fiscal 2007 and all years thereafter. It also imposes the same rate reductions on fees associated with merger and tender offers. The collections resulting from these rates are reclassified as offsetting collections that would be available to the SEC's appropriators to fund the Commission.

In addition, the proposal would set, on a yearly basis, the Section 31 (transaction) fee rate. This rate would be determined by taking the total amount of offsetting collections available to the Commission's appropriators under CBO's upcoming budget resolution baseline, subtracting the anticipated Section 6(b) and merger and tender offer fee collections discussed above, and dividing the remaining amount by the estimated dollar volumes for both the exchanges and the over-the-counter markets. All of the fees collected under this mechanism likewise would be made available to fund the agency as offsetting collections. Although CBO will need to opine on the more technical aspects, this approach should limit the amount of total fees collected to those in the CBO's offsetting collections baseline through 2010. In fiscal 2001, this mechanism could result in a Section 31 fee rate that is nearly half the current rate of 1/300th of 1 percent (or $33 per million).

This proposal achieves significant reductions in total fees by targeting the general revenue portion of collections, which accounts for nearly 70 percent of all SEC fees and is estimated to reach $1.3 billion in fiscal 2001. While there are rather complex Pay-As-You-Go ("PAYGO") budget scoring rules that may affect the ability of Congress to reduce the general revenue portion of fee collections, the Commission believes that it would be difficult to achieve truly meaningful reductions in fees, as well as to provide full and stable long-term funding for the SEC, without addressing the general revenue portion of fee collections. That said, we are not in a position to address the larger tax policy issue without consulting the Administration and the appropriators.

The proposal also improves the likelihood that the SEC will receive adequate funding in the future. It does this by preserving the ability of our appropriators to fund SEC operations out of offsetting collections.7 For this reason, we applaud your efforts to take into account SEC funding issues when crafting this proposal. By taking this approach, your proposal facilitates the Commission's continuing efforts to protect investors and promote the integrity and efficiency of the nation's securities markets. We note, however, that the success of this proposal depends on the Commission receiving an up-front appropriation each year that would be reduced by offsetting collections as they are collected. Although we do not believe that this ultimately will be a problem, the need for an up-front appropriation underscores the need for an inclusive dialogue on these complex issues.

Last, the proposal recognizes the importance of using SEC fees to pay for the costs of regulation. It does this by insuring that, going forward, Sectionfee collections will go to offsetting collections. In addition, for the first time merger and tender offer fees are shifted to offsetting collections under this proposal. Because our appropriators fund agency operations out of offsetting collections, these changes ensure that the costs of federal securities regulation are divided more evenly.

Staffing Crisis

We now would like to discuss the second issue that the "Competitive Market Supervision Act" attempts to address: the Commission's inability to attract and retain a sufficient number of qualified staff. The SEC is in the midst of a serious staffing crisis. In the last two years, the Commission has lost 25% of its attorneys, accountants, and examiners. These losses are adversely affecting the Commission's continuing efforts to protect investors and promote the integrity and efficiency of the nation's securities markets. The Commission is losing staff before they become fully productive because we cannot pay them enough. In a world where first-year associates are making six-figure salaries in Washington, D.C. law firms, the salaries the SEC can provide are simply not competitive to attract and retain a sufficient number of talented professionals to reduce high turnover, let alone to fill open positions.

The following figures and comparisons give a sense of the magnitude of this crisis. First, in fiscal 1998 we lost 138 attorneys (15.2%) and 44 accountants (12.9%). Last year, these losses increased to 150 attorneys (13.5%) and 89 accountants (16.8%). Second, the average length of stay for a new SEC attorney is only 2.5 to 3 years. Third, the SEC's fiscal 1999 turnover rates for attorneys, accountants, and examiners were 13.5, 16.8 and 9.9 percent respectively, compared with government-wide averages of 7.0, 8.0, and 5.6 percent in 1998, the last year for which data is available.

While we fully recognize that the SEC cannot completely match the higher salaries offered by brokerages, law firms, self-regulatory organizations, and other securities-related businesses, something needs to be done to close the pay gap and reduce the turnover problems we face.8 Practically every day at least one of my senior managers comes to me expressing his or her frustration in not being able to keep tomorrow's leaders.

Effect on the Commission

Our current level of turnover and inability to attract qualified staff is threatening our ability to oversee the nation's securities markets and to respond in a timely manner to the changing events and innovations in our markets by:

hampering our ability to bring cases to trial and disrupting the continuity we need when pursuing cases;

hindering us from responding to changing markets in a timely fashion, including through targeted de-regulatory efforts;

limiting our institutional memory, which is a crucial component of our long-term effectiveness as a regulator; and

lowering employee morale, which in turn reinforces the staffing crisis.

We also become less productive. SEC staff work hard to handle the Commission's increasing, and increasingly complex, workload. The time that our managers and senior staff have to devote to this workload is, however, reduced by the time it takes to recruit and train new staff. In addition, the SEC conservatively estimates that it takes approximately two years for new staff to become fully productive. During this period, new staff is somewhat of a drag on the efficiency of the agency because they are still moving up the learning curve. If these staff leave right around the time when they become fully productive to the agency, we do not break even on our investment in training them. That is a loss not only for us, but also for the investing public and our markets.

Retention Efforts

Over the past several years the Commission has explored virtually every available approach to keeping staff longer. In 1992, we petitioned and received from the Office of Personnel Management the authority to pay the majority of our attorneys and accountants approximately 10 percent above their base pay. While special pay was a step in the right direction, it proved to be a short-term solution. This is because staff that receive special pay do not receive the government-wide locality increase each year, which means that their special pay becomes less valuable over time and hence becomes less effective as a retention tool. In addition to our special pay authority, which the President's fiscal 2001 budget requests the funds to reinstate, the Commission has used retention allowances and economist special pay to help alleviate our retention problem. While all of these tools have proved somewhat effective when targeted to specific staff and situations, we believe they are incapable of providing the broad relief that we need to combat the Commission's losses and treat all staff fairly.

Recruitment

The SEC is also facing a problem in recruiting attorneys and accountants. We have used recruitment bonuses where possible, but have not met with much success. A typical first-year associate in a top-tier New York or Washington D.C. law firm makes double, if not more, than a comparable staff attorney at the SEC. The costs of three years of law school leave most graduates entering the job market with significant amounts of student loan debt. It is not difficult to understand why the private sector looks so appealing.

Our problem is even worse for accountants, who need to be experienced when they walk in the door. Experienced accountants are difficult to find and expensive to hire because their ability to analyze complex financial statements is highly prized. We do not have the luxury, if you can call it that, of being able to take someone directly out of school. The Commission has attempted to ameliorate this problem by developing an "in-service" placement program that allows certain Securities Compliance Examiners to be reassigned as accountants if they meet specific criteria, but even this effort has fallen short. In fact, last year only 46 percent of our available positions were filled. This hiring rate is not sustainable. The Commission needs the ability not only to keep staff longer, but also to bring them to the Commission in the first place.

Parity With the Banking Regulators

Another real concern the Commission has about staff salaries is the effect of the landmark Gramm-Leach-Bliley Act of 1999 ("GLBA"). By allowing securities firms, banks, and insurance companies to affiliate with one another, GLBA requires increased coordination of activities among all the financial regulators. Even more so than in the past, Commission staff will work side-by-side with their counterparts from the banking regulatory agencies, like the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. However, we cannot match the salaries that these regulators pay.

Since all of the federal banking regulators are off the government-wide pay schedule, they are able to provide their staffs with appreciably more in compensation and benefits than we can. This is a significant drain on morale. It is difficult to explain to SEC staff why they should not be paid at similar levels, especially when they are conducting similar oversight, regulatory, and examination activities. It is one thing for staff to make salary comparisons with the private sector, but quite another for them to see their government counterparts making anywhere from 24 to 39 percent more than they are. Moreover, the Commission has already seen several staff leave to take positions with these agencies, primarily because of pay. Unless we are put on equal footing, this trend will continue and most likely intensify.

Given the complexities of our markets and the new business affiliations we are likely to see, the SEC does not believe it is at all beneficial to have the financial regulators poaching from one another based on pay. Instead, we should be working together from the same starting point. Towards that end, the Commission believes that providing our staff with pay comparable to the banking regulatory agencies would significantly help in extending the tenures of key employees and help the Commission attract sufficient staff in the first place.

The Agency and Its Staff

The SEC should be a place where highly motivated people come to hone their skills and perform public service, both before entering the private sector and after a stint in the private sector. Such career paths speak highly of the Commission's professionalism and the industry's regard for the agency and its staff. However, the Commission should be able to keep staff for a minimum of three to five years before they leave, and show existing staff how much their efforts are valued. The SEC can ill afford to have its future walk out the door. Moreover, we need to ensure that the Commission has the staffing resources to meet the significant regulatory challenges that lie ahead as technology in general, and the Internet in particular, continue to re-shape our markets.

Cost of Pay Parity

Last, we would like to briefly discuss how much it may cost to address the Commission's staffing crisis. By our estimates, implementing pay parity with the banking regulators, as your legislation proposes, would cost approximately $52 million in fiscal 2001, with yearly increases for inflation thereafter.9 Although this is a significant amount of money, it is crucial for the Commission to have the resources it needs to fulfill its mission. The most vital resource we have, ultimately, is our highly professional and well-regarded staff. This is the one area we can least afford to jeopardize.

Conclusion

The proposed "Competitive Market Supervision Act" addresses two important challenges to the Commission's continuing efforts to protect investors and promote the integrity and efficiency of the nation's securities markets. First, the proposal achieves significant reductions in excess fee collections while addressing most of the SEC's concerns. Second and most importantly, the proposal addresses the SEC's serious staffing crisis by providing the SEC pay parity with federal banking regulators. We appreciate your recognition of these challenges and commend the comprehensive manner in which you address them. Moreover, we look forward to continuing an inclusive, reasoned dialogue with you and other interested parties on this proposal.

5These gradual increases were central to the NSMIA compromise because of the practical realities of the budget process  it is difficult to maintain full and stable funding for the SEC in the context of a sudden shift to general revenue.

7A technical concern we have with the proposal involves the impact of the fixed dollar cap on Section 31 fee collections after fiscal 2010. We hope to continue working with the Committee on this issue.

8The Commission recently contracted for a study comparing the significant disparity between SEC salaries and what the private sector offers for the same line of work. We would be happy to share the results of that study if you think it would be helpful in highlighting the magnitude of our problems.

9Since the SEC's fiscal 2001 budget request of $423 million currently includes $15 million to reinstitute special pay, the total net increase required to fund pay parity in fiscal 2001 is $37 million.